CONTEMPORARY ISSUES IN
ACCOUNTING
AF0403
BACHELOR IN ACCOUNTING AND FINANCE –YEAR 4
LEARNING OUTCOMES
• Explain the concept of accounting theories and describe the importance of
accounting regulation.
• Specify the international accounting and measurement issues on income and assets
• Demonstrate conceptual framework projects and explain normative accounting
theories
• Analyze social responsibility of reporting
• Discuss the reactions of capital markets to financial reporting
• Evaluate the reactions of individual to financial reporting
• Discuss critical perspective of accounting
TOPIC 1
INTRODUCTION TO FINANCIAL
ACCOUNTING THEORY
INTRODUCTION
• How accounting theories help accounting profession?
• Why I should learn accounting theory?
• What is theory?
• Theories and Events or facts – Are they related?
• Developing theory by individuals – How?
• How can accounting theories help the
accounting profession?
Without a theoretically informed understanding it is difficult to:
• evaluate the suitability of current accounting practices
• develop improved accounting practices where current practices are
unsuitable for changed business circumstances
• defend the reputation of accounting when accounting practices are
blamed for causing companies to fail (as has been the case with the
global financial crisis)
• WHY STUDY ACCOUNTING THEORIES?
• Learning the rules of financial accounting without considering the
implications of accounting information is not recommended
• Accounting plays a very important and pervasive role within
society….and our theories help to explain why: accountants are very
powerful members of society!
• Studying theories of accounting enhances your ability to be a critical
thinker and differentiates you from ‘the average accountant’
• WHY STUDY ACCOUNTING THEORIES?
• Studying theories of accounting exposes students to various issues, including:
• how elements of accounting should be measured
• the motivations driving organizations to provide certain types of accounting information
• the motivations driving individuals to support or lobby regulators for some accounting methods
in preference to others
• the implications for organizations and their stakeholders if one accounting method is chosen
or mandated in preference to others
• how and why the capital markets react to particular information
• whether there is a ‘true measure’ of income
DEFINITION - THEORY
• A statement of belief expressed in a language.
• A theory is a set of logical statements or arguments,
concluding with statements of belief, which can be
explanations, predictions or prescriptions.
➢ Astronomy: Big Bang Theory.
➢ Biology: Cell Theory; Theory of Evolution; Germ Theory of
Disease.
➢ Chemistry: Atomic Theory; Kinetic Theory of Gases.
➢ Physics: General Relativity; Special Relativity; Theory of Relativity;
Quantum Field Theory.
DEFINITION
• A theory is a well-substantiated explanation of an aspect of
the natural world that can incorporate laws, hypotheses and
facts.
• The theory of gravitation, for instance, explains why apples
fall from trees and astronauts float in space. Similarly, the
theory of evolution explains why so many plants and
animals—some very similar and some very different—exist
on Earth now and in the past, as revealed by the fossil
record.
DERIVATIONS OF THEORY
• Three types of relationships are important to theoretical
structure:
• 1. Syntactics
• 2. Semantics
• 3. Pragmatics
• 1. SYNTACTICS
It refers to the logic contained in an argument. It has nothing to
say about the real world, but it is concerned with the rules,
definitions and premises and how the conclusion was derived
from these.
• 2. SEMANTICS
It relates to the basic concepts of a theory to real world objects.
The relationship between the theoretical and its real-world
counterpart is known as the rule of correspondence. The more
precise the definition of the rules, the more closely the basic
concepts correspond to their real-world counterparts.
• 3. PRAGMATICS
It is not essential to a theory because it relates to the effects of
words and symbols of theory on people.
CHARACTERISTICS OF AN IDEAL THEORY
1. An ideal theory must possess the quality of having an authenticity. It
should be authoritative.
2. A good theory should have wide acceptance.
3. An ideal theory should have the quality of evaluating and explaining
the current events correctly.
4. An ideal theory is likely to possess the potentiality of solving the
problems created by the happening of an event.
CHARACTERISTICS OF AN IDEAL THEORY
5. A good theory should be a verified and confirmed hypothesis.
6. An ideal theory should have the ability of analyzing past events
also.
7. A good theory should also have the quality of being able to forecast
regarding any future event.
8. An ideal theory should always have some descriptive approach in
general and a normative approach in particular.
ACCOUNTING THEORY
• Accounting is a human activity (if no humans then no ‘accounting’)
• It would seem illogical to study financial accounting (for example, the
accounting standards) without also studying accounting theory
• Theories of accounting consider:
– why particular accounting rules are mandated by regulators
– people’s behaviour with respect to accounting information
– people’s needs for accounting information
– why people within organisations elect to supply particular information
DEFINITION OF ACCOUNTING THEORY
• Accounting theory is a set of assumptions, frameworks, and
methodologies used in the study and application of financial
reporting principles.
DEFINITION OF ACCOUNTING THEORY
“Accounting Theory may be defined as logical reasoning in the form
of a set of broad principles that provide a general frame of reference
by which accounting practice can be evaluated and guide the
development of new practices and procedures.
KEY ELEMENTS OF ACCOUNTING THEORY
Relevance - this is a crucial element of an accounting theory.
Information provided by accounting theories are relevant in all
aspects.
Usefulness - accounting theory is useful for the compilation of
financial reports of statements. It helps corporate businesses make
informed decisions as regards finance.
KEY ELEMENTS OF ACCOUNTING THEORY
Reliability - an accounting theory is reliable. It follows the standards of
general accepted accounting principles (GAAP).
Consistency - This is another key element of accounting theory.
Furthermore, accounting theory generally maintains that professionals in
the accounting industry operate based on assumptions which are;
Discrepancy between a business and its owner, continuity of the business,
preparation of financial statements using dollar representation and
compilation of statements monthly, quarterly or annually.
CLASSIFICATIONS (LEVELS) OF ACCOUNTING
THEORY
At present, a single universally accepted accounting theory does not
exist in accounting. Instead, different theories have been proposed
and continue to be proposed in the accounting literature.
The development of accounting practices which employs a problem
solving approach is shown in the right hand side of the diagram. As
particular problems occurred in dealing with individual business events
practicing accountants would look for separate procedures to solve these
specific problems. “The history of accounting practice consists of a
problem ...... procedure evolution ....... the development of new, or
modification of old, procedures as different problems occurred”.
In other words, the approach adopted in the development of accounting
practice can be epitomized as, “Accounting is what accountants do”
The development of accounting theory, which has taken place concurrently
with that of accounting practice is shown in the left hand side of the
diagram. The first step in the development of accounting theory is
abstraction from the real world of business transactions to make some
assumption about them. From these assumptions conclusions can be
developed about accounting activities through deductive logic.
This procedure would suggest “Accounting is what accountants should be
doing”.
Descriptive and normative theories :
From the foregoing it appears that accounting theory can be extracted from
the practice of accounting (i.e., the practical approach) or it can result from
a logically derived process through the deductive approach. The difference
in not one of purpose, rather the difference is due to adoption of different
methodologies. “The divergence of opinions, approaches and values
between accounting practice and accounting research have led to the use of
two methodologies, one descriptive and the other normative.”
Descriptive Theory:
A descriptive theory describes a particular phenomenon as it is, without any value
judgment. This theory is concerned with What Is. For example, if you jump from
Burj Khalifa, a descriptive theory will tell you when you will descend on earth, it
will not tell you whether you are right or wrong in doing so. The practical or
conventional approach to accounting theory is essentially descriptive in character.
Such descriptive theories are concerned with the behavior of the practicing
accountants and what they do. This approach emphasizes accounting practice as
the basis from which to develop theory.
The prominent examples of descriptive accounting theories are the
works of Paul Grady, An Inventory of Generally Accepted
Accounting Principles for Business Enterprise, Sanders, Hatfield and
Moore, A Statement of Accounting Principles, Stephen Gilman,
Accounting Concepts of Profit, A.C. Littleton, Structure of
Accounting Theory, and Yuji Ijiri, The Foundations of Accounting
Measurement.
Normative theories :
The essential feature of Normative Theory is the existence of value
judgement. Normative Theories tend to justify what ought to be,
rather than what it is. It imposes on the accountants responsibility of
determining what should be reported rather than merely reporting
what some on else has requested. It is concerned with What Should
be done.
The outstanding examples of normative accounting theories are the
works of J.B. Canning, The Economics of Accountancy, W.A. Paton,
Accounting Theory, Henry Sweney, Stablized Accounting, Kenneth
McNeal, Truth in Accounting, Edwards and Bell, The Theory and
Measurement of Business Income, and Sprouse and Moonitz, A
Tentative Set of Broad Accounting Principles for Business Enterprise.
Point of Difference Normative Theory Positive or Descriptive
Theory
Focus What Should Happen What is Happening and
what will probably
happen in future.
Ethics Value Driven – Right vs Evidence Driven –
Wrong Values not considered
Purpose Prescriptive Descriptive or Predictive
Decision Decision Model Emphasis Decision Maker
Usefulness Emphasis
Approach
The roots of accounting theory :
The development in accounting theory has been influenced by the
technological changes and advances in knowledge in many other
related disciplines. The major disciplines which have influenced such
development are:
1. Decision Theory
2. Measurement Theory, and
3. Information Theory
1. Decision Theory
The essence of this theory is that decision-making is not an intuitive
process but a conscious evaluation of the possible alternatives that
leads to best result or optimizes the goal.
Decision theory is both descriptive and normative. As a descriptive
process it attempts to explain how decisions are made, while as a
normative process it suggests which decision is to be made.
2. Measurement Theory
Measurement is an important aspect of accounting theory.
Measurement is defined as the assignment of numbers to the
attributes or properties of objects being measured, which is exactly
what accountants do.
Accounting measurement is the computation of economic or financial
data in terms of money, hours, or other units.
Measurement theory is normative in character. In accounting, money
is the most common unit of measure, not because that it is convenient
but due to the ability of monetary unit to attach common significance
to diverse events and objects which are subjected to accounting
measurement.
3. Information theory
Information is the source of a communication system, whether it is
analog or digital. Information theory is a mathematical approach to
the study of coding of information along with the quantification,
storage, and communication of information.
The significance of information theory to accounting lies in the fact
that it is a part of the decision-making process that reduces
uncertainty and thereby provides a means to improve the quality of
decision. Information theory in particular can help accounting to
resolve certain important issues such as : What is an information ?
What is the relationship between information and data ? What should
be an accounting information and what should be the system or
systems by which to communicate the information ?
When the receiver of a data reacts to it, it is said to carry information.
A data is thus distinguished from information. According to Bedford,
however, a data becomes accounting information only when it is
measured and is bounded by the criteria of relevance, verifiability,
freedom from bias and quantifiability.
Under this theory, information is regarded as a resource, the
collection, processing and transmission of which involve a cost. Such
costs accelerate with the increase in the volume of information. It is,
therefore, important to associate the process of information
generation with the economics (i.e., costs) associated with it. Only
this criterion can help us to consider the optimal level of information
supply by measuring cost of information supply in relation to its
benefits to the users.
EVALUATION OF THEORY
• Theories of accounting are only abstractions of reality
• The choice of one theory in preference to another is based on
value judgements
• Theories of accounting cannot be expected to provide perfect
explanations or predictions of human behavior or assess what
types of information users actually need.
EVALUATION OF THEORY
• When evaluating theories, you need to consider:
✓ whether the argument supporting the theory is logical
✓ whether you agree with the central assumptions of the theory
✓ whether you accept any supporting evidence provided
EVALUATION OF THEORY
• Acceptance of an argument must be based on the accuracy of the
premises
• an argument is logical to the extent that if the premises on which it
is based are true, then the conclusion will be true
• We do not need to refer to ‘real world’ observations to determine
the logic of an argument
• However, although the argument might be logical, if it can be
shown that a given premise is untrue then the conclusion or
prediction may be rejected.
Overview of key factors that influence research
• Different theories will generate different research questions, and
require different research methods
For example, a positive theory of accounting will ask questions
about when accountants will be likely to use particular accounting
methods, and will empirically investigate actual practice to answer
the questions
• Theories will often be based on key assumptions that in turn are
influenced by the ‘values’ of the researcher and how the researcher
‘sees’ the real world
• Assumptions about individual behavior and whether there is an
‘objective reality’ out there are referred to as ontological
assumptions – which are assumptions about how we see the world
• Therefore, we can summarize by saying that the ontological
assumptions held by the researcher, their values and beliefs, the
theory being used, the research questions to be addressed, and the
research methods to be used are all highly inter-related.
• For example, a researcher that does not believe in an ‘objective
reality’ in which all people act in the same predictable manner will
not do large scale empirical research utilizing statistical testing
with the objective of developing generalizable hypotheses
• These inter-relationships are reflected in Figure 1.1 on the
following slide:
